Homework # 5 Answer Key
1. Using the data for the market for wool (from homework #3 ):
b. calculate the producer and consumer surplus in the case of a perfectly competitive market.
CS = ˝ (160-60)(100) = 5000, PS = ˝ (60-10)(100) =
2500, TS= 7500, TR = 60*100 = 6000
c. If a tax is placed on the market so that the price rises to $80, how many sweaters will be supplied and demanded?
Q = 80
d. What will happen to total revenues, consumer and producer surplus? Calculate and show graphically. Also identify the dead weight loss created by the monopolist on the graph.
e. What must be true about the elasticity of demand in this case? Use the total revenue method and see that as the price rose, the total revenue rose as well, from $6000 to $6400, suggesting that demand is inelastic.
f. Is the monopoly or perfect competition solution preferable from the point of view of society/economic theory? Discuss both in terms of equity and efficiency.
PC is more efficient, because monopolist creates DWL. Equity concern is that monopolist takes away some of the CS.
3. Read the following two articles about the tobacco market, summarize them and identify the relevant economic concepts and policy issues that are raised by them.
http://www.duke.edu/web/soc142/team11/globalvaluechain.htm
www.itepnet.org/pb1cigs.pdf
Relevant terms: globalization, production, export, consumption, marketing, branding, concentration, elasticity, tax, regressive, tax revenue, externality
The first article discusses how cigarette production and consumption has shifted in recent years, away from the US to countries such as China. It also discusses how the cigarette companies try to assure a customer base. Basically they use marketing to create brand loyalty and are quite successful at this. One example is the Marlboro Man. The second article discusses the pros and cons of taxing cigarettes. The article points out that while taxing cigarettes does raise revenue initially, it is a regressive tax, which means that it affects the poor more than the rich. It also points out that over time, people find ways to avoid the tax, so it can’t be relied on as a long term solution to the need to raise revenue, but may help reduce consumption. Finally, a point we will return to after this exam – it provides an example of another type of externality associated with cigarettes – the risk of a fire.
4. Read the article titled Price Wars (link also at my web page), and summarize it. What relevant economic concepts and policy issues are raised in this article?
Relevant terms: pricing, market power, barriers to entry, high fixed costs, low marginal costs, total cost/revenue, profits, market share, mergers (consolidation), short/long run
This article points out that there has been some fierce competition in the communications industry (cellphones/internet). This competition can help customers in the short run, by driving down prices, but may not last. Why? Because communications is an industry that has high barriers to entry and low marginal cost. So the large firms can charge very little in the short run and either drive the smaller companies out of business, or buy them up. I don’t agree with the article’s conclusion, because the author says that the best consumers can hope for is a stream of new innovations, but government regulation may also be necessary to keep the communication industry from becoming one giant firm that can take advantage of consumers.
5. Go to the web page www.njpirg.org
What type of organization is this? Can you identify any economic issues
they are involved in?
NJ PIRG (Public Research Interest Group) is a NJ based organization that fights for consumer rights, particularly in the face of powerful special interest groups. Some issues they are concerned with include: public control of transportation (eg roads etc), preventing mergers, esp. energy and media mergers, product safety, esp. in the area of pharmaceuticals and the environment. Basically this organization is concerned with all the areas where, as we discussed, the market may not work very well, including: limiting market power, preventing negative externalities, providing complete information, encouraging public goods. We will talk more about this organization and the types of issues they are concerned with after this midterm.